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The Insights of the Solow Model

Table of Contents

Introduction
Main Body
Conclusion
References

Introduction

Various economic growth models have been developed over time. These models help us to understand the sources of economic growth and why there are differences in economic performance across countries. One of these models is the Solow-model, called the neoclassical growth-model. The concept became established in the fiscal 1956 by Swan Trevor and Robert Sollow as an extension to the Domar- Harrod concept. According to Dalgaard and Erickson (2006), the model was a better version of the fixed co-efficient model of Harrod Domar.

Main Body

The Solow Model is an exogenous growth model as it assumes that external factors tend to influence economic prosperity (Gundlach, 2005). In essence, it is set by the contents of neoclassical economists and is meant for long-term economic growth. The Neoclassic economists assume that the economy comes together towards a steady-state economy. It tries to explain the long-term growth in terms of labour and increase in productivity, which accrue due to technological progress and capital accumulation. It is has been proven to be a good beginning for various extensions. It modifies Harrod Domar model by aligning labour as a factor of production and capital-labor ratios not being fixed. The assertion enables technological progress to be differentiated from the increasing capital intensity.

The short-run implication of the Solows model is that shifting to the steady state determines growth. The balanced condition emerges due to the devaluation percentage, growth in workers, and the variation in invested capital. The lasting effect is that the original stable condition at some point will be equivalent to accrued developments and this will imply no more development. Thus, when improved through human resources, the concept envisages that the underprivileged nations revenues could try to draw level or move in the direction of the developed nations revenue levels. However, the situation occurs if the poor countries would save as rich states do and have similar saving rates for both physical and human capital. Growth evolves from innovations and advancement in technology as well as in increased capital and labour inputs (Easterly & Levine, 2003). A stable state development path is achieved when all these factors are increasing at the same rate, such that capital per employee and the yield per labourer hardly fluctuate. The variations in growth rates between countries are explained by the differences in the rate of technological change amongst them.

The assumptions of the model are that technology is free, the saving and depreciation rate is constant and that labour increases at a constant rate. It is a closed system meaning there is neither government nor international trade. Gundlach (2005) in a study claims that there are major differences between Solows Model and Harrod Domars model. For instance, Solow is a Neoclassical model which is based on capital, labour, and technological advancement for economic growth. However, Harrod Domar isa Keynesian model, which is based on the saving ratio, capital, and capital-output ratio. Solow believes that as you keep increasing capital there is always a diminishing return to it. Capital is developed on a known technological advancement that continues improving. Based on this, the old capital reduces in value and the new one becomes more valuable.

Solow does not emphasise on capital accumulation as a determinant of growth (Gundlach, 2005). Instead, Solow showed that technological change is the driving force for steady growth (Solow, 2001). The capital-labour ratios are not stationary given that they keep on changing. However, the Horrad Domar model emphasises on the exogenous factor accumulation as the determinant of growth. Besides, the model has fewer restrictions as compared to the Solow model. For instance, it does not assume that there is any particular price factor adjustment and existing stable macroeconomic equilibrium.

Conclusion

Solows model shows that increased economic growth is based on technological advancement. Though the model provides a better understanding of the role of technology and innovation in growth and allows for the substitution between inputs, it differs with Harrod Domars model that advocates for saving ratio, capital, and capital-output ratio to spearhead growth.

References

Dalgaard, C. & Erickson, L. (2006). Solow versus Harrod-Domar: Reexamining the aid costs of the first millennium development goal. IMF Working Paper.

Easterly, W., & Levine, R. (2003). Tropics, germs, and crops: How endowments influence economic development. Journal of Monetary Economics, 50(3): 3-39.

Gundlach, E. (2005). The Solow model in the empirics of cross-country growth. Kiel Germany: Institute for World Economics.

Solow, R. (2001). Applying growth theory across countries. The World Bank Economic Review, 15(2): 283288.

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